• SingTel's earnings rebound likely in FY20F with the potential recovery of Bharti; Singtel opens to partial exit opportunities from digital businesses in 2-3 years.
• Potential risk of -7% under our bear-case scenario versus +21% reward under our base-case scenario.
• BUY with a lower Target Price of S$3.70 as we adjust our core EBITDA and market cap of associates.

Temporary Earnings Decline Presents An Opportunity to Accumulate

We expect Singtel’s earnings to rebound by FY20F, driven by the potential earnings recovery of Bharti (earnings recovery may delay to FY21F under our bear case scenario for Bharti). 

Excluding market cap of its associates, Singtel’s core business is trading at only 5.5x FY19F EV/EBITDA, at ~15-20% discount to its local peers.

With 5.4% yield, we see potential risk of -7% vs potential reward of +21%.

Where we differ: Digital businesses’ monetisation may lead to value accretion of S$0.16 per share.

We argue that Digital Life! and cyber security businesses are worth S$0.13 per share based on ~1x revenue multiple versus market ascribing them a value of -S$0.03 per share.

Singtel is open to partial exit opportunities from its cyber-security and Digital Life! businesses over the next 2 years via a sale to a strategic investor or public listing.

Potential Catalyst: Final DPS of S$10.7 Scts going ex in late July, price hike by Telkomsel in 2H18F and Singtel raising stake in regional associates.

Final DPS of S$10.7 Scts will go ex on 26 July.

Telkomsel, who is the biggest earnings contributor to Singtel, may raise data pricing by 5-10% in 2H18F.

Singtel may also look to raise its stake in AIS or Bharti, enhancing its FY19F/20F earnings.

Valuation:

BUY with a revised Target Price of S$3.70. We lower our sum-of-the- parts (SOTP) valuation to S$3.70, mainly from

1. FY19F core EBITDA growth of +1% vs +4% earlier, and
2. recent drop in the market capitalization of Bharti and AIS.

Key Risks to Our View:

Bear-case valuation of S$2.79 suggests -7% risk. This assumes

1. 23% drop in valuation of the core business due to EBITDA decline versus stable EBITDA expectations;
2. 20% drop in Bharti’s & Telkomsel’s valuation and 10% drop in market cap of other associates;
3. 15% holding company discount vs. 5% base case.

WHAT’S NEW: Short-term Pain Before Long-term Gain

When will Singtel’s earnings return to a growth trajectory?

We project Singtel’s earnings would rebound in FY20F, after contracting in FY19F. Rebound in FY20F would be primarily driven by the recovery of Bharti Airtel for two key reasons.

1. Airtel is set to gain revenue market share from the ongoing Vodafone-Idea merger, which is fraught with complications caused by vendor and staff issues. Vodafone is also highly levered with a net debt-to-EBITDA of 6.5x, limiting its potential to counter aggressive pricing measures of Reliance Jio or expand capacity, which the telco is seemingly having issues with. Vodafone is also losing subscribers as it has not adopted cheaper bundled plans due to the lack of capacity. Armed with a stronger network coverage and capacity, we project that Bharti Airtel will have the opportunity to increase its revenue share over the next 12-15 months on the back of Vodafone’s weakness.
2. The integration of Tata telecom’s spectrum and subscribers, expected to take place over FY19F, should also help Bharti Airtel’s efforts to uplift its revenue share gains and earnings.

Hence, we expect to see a substantial improvement in contributions from Bharti Airtel by FY20F, putting Singtel’s earnings back in positive territory.

What could potentially delay a rebound in Singtel’s earnings by FY20F?

We see the recovery of Bharti Airtel as the key catalyst for a rebound in earnings by FY20F. However, if competitive pressures in the Indian telecom market persist, with an aggressive Jio continuously driving tariffs lower in a bid to gain revenue share, a potential recovery of Bharti Airtel and consequently a rebound in Singtel’s earnings could be further delayed to FY21F.

Jio continues to be aggressive in the market, maintaining ~20% lower tariffs vs. incumbents as it continues to battle towards gaining further revenue market share by 2021 vs 25% presently. However, much of these market share gains will be at the expense of smaller operators and Vodafone-Idea with minimal losses expected from Airtel.

In our base case, we have assumed that Jio will adopt a more moderate competitive stance and move away from price competition by 2020, once the consolidation of the industry is completed, with the hope of monetising Jio’s subscriber base. However, if Jio continues to maintain competitive pressures at the present hyper-intensive levels, even after industry consolidation, Airtel may fail to stage a recovery in earnings, prolonging a rebound in Singtel’s bottomline.

We trim our FY19F earnings forecast by 5%.

We forecast a 6% y-o-y decline in underlying earnings for FY19F on the back of

1. projected decline in contributions from associates driven by Bharti Airtel and Telkomsel, and
2. intensifying competition in the mobile and enterprise services market in Singapore, that could weigh on core EBITDA.

Competitive pressures and the curtailment of inter-connection charges by the regulator in India will continue to weigh on contributions from Bharti Airtel for FY19F.

Meanwhile, the prepaid SIM registration exercise in Indonesia, which concluded in May 2018, has also taken a toll on Indonesian mobile operators and could likely weigh down contributions from Telkomsel further in FY19F. However, Telkomsel who has been the aggressor so far, plans to raise data pricing by 5-10% post Lebaran holidays and hopes to sustain higher pricing if other players follow suit.

We expect core EBITDA from Singapore and Australia to show 1% decline in FY19F and FY20F each due to tightening competitive pressures in the Singaporean mobile market and declining margins in the enterprise market with higher Infocomm Technology (ICT) contribution.

Core Business Trading at 15-20% Valuation Discount Vs Local Peers Is Hard to Justify

The market is attaching a significant valuation discount to the core plus digital business of Singtel, possibly over concerns on the magnitude of losses in the digital segment in the past. This has resulted in Singtel’s core plus digital businesses trading at only 5.5x FY19F EV/EBITDA vs 6.8x for M1 and 7.5x for StarHub, despite having a much more resilient business model.

We have valued Singtel’s Singapore and Australia operations at FY19F EV/EBITDA valuations of 7x each. Digital Life! And Cybersecurity businesses (Digital businesses) were valued at an EV/Revenue multiple of ~1x. The valuations of regional associates are based on current share prices, while the valuation of Telkomsel is based on a FY19F PE (March YE) of 15x as we assume a 10% y-o-y drop in Telkomsel’s earnings.

Bear-case valuation

Bear-case assumptions for the core business: We have assumed FY19F core EBITDA to be 4% lower than the base-case scenario with an EV to EBITDA multiple of 6x vs 7x in the base-case scenario.

Bear-case assumptions for associates: We have assumed 20% drop in Bharti’s stock price due to higher-than-expected competition, 20% drop in valuation for Telkomsel due to 15% earnings decline vs 8% decline under the base case, a 10% decline in the stock price for other associates and a wider holding company discount of 15% vs 5% under the base case.

Source: DBS Research - 18 Jun 2018